Kim and Robert Canfield filed for bankruptcy last summer to save their home from foreclosure. The Saugus couple makes about $5,500 a month after taxes. Their monthly mortgage payment had climbed above $3,000. The house has been in Robert's family since the 1920s, but they could no longer afford the payments.
Bankruptcy courts are empowered to reduce debts to manageable proportions for people who file under Chapter 13 of the US Bankruptcy Code. A rush of people similarly desperate to keep their homes contributed to a 57 percent increase in Chapter 13 filings in Massachusetts for the fiscal year that ended in September.
But as the Canfields learned, there is one debt the courts can't touch: The mortgage loan on the home where you live. Bankruptcy courts are better equipped to save your car than to save your home. Now, with tens of thousands of Americans facing foreclosure unless their mortgage payments are reduced, support is growing to let bankruptcy courts modify mortgage loans.
Mortgage companies "are not doing it on their own," said US Representative Brad Miller, a North Carolina Democrat who has proposed legislation allowing courts to modify mortgage loans. "I think that borrowers should have some rights and not just have to rely on the benevolence of lenders."
The bill is strongly opposed by the mortgage industry, which warns that interest rates would rise for all borrowers. The industry says the mortgage exception protects lenders against a potential loss of revenue, which lets them offer lower interest rates. The legislation would apply solely to existing loans, but the industry says it still would undermine investor confidence that future mortgages won't again be modified.
"As a society, we invest in home ownership through the bankruptcy law," said Francis Creighton, vice president of legislative affairs at the Mortgage Bankers Association. If the law changes, he said, "The market will have to price in the possibility that Congress is going to step in once again and abrogate contracts."
Large numbers of foreclosures are displacing families and damaging neighborhoods nationwide. Housing analysts predict a million people could lose homes this year. Policy makers are grappling for responses.
The mortgage industry pledged in December to reduce payments for some borrowers. The bankruptcy bill would create a parallel process, allowing borrowers to seek reduced payments without the lender's cooperation.
The law would allow bankruptcy judges to cut a borrower's monthly payment in two ways, by shrinking the size of the loan and by lowering the interest rate. The depth of the cuts would be limited. The loan balance could be reduced to match the home's value. If a person owed $200,000 and their home was worth $175,000, the judge could reduce the loan amount to $175,000. The interest rate could be lowered as far as the prevailing rate on conventional loans.
If the borrower was able to make the payments at the adjusted level, they could keep the home.
The Canfields bought their home from a relative in 1996 for $155,000. For the next five years, they made regular payments on a conventional mortgage loan. Then, between 2001 and 2004, they refinanced three times, ultimately borrowing $330,000. They used much of the money to repay thousands of dollars in credit card debts.
The last loan, from Long Beach Mortgage, a subsidiary of Washington Mutual, carried an introductory monthly payment of $2,400. The Canfields were making as much money as they ever had. Robert pulled in good overtime driving a trash truck. Kim was working three jobs. The payments were affordable.
Over the next two years, Kim took a full-time job at a call center and Robert's overtime diminished. In 2006, when the interest rate on the mortgage loan started climbing, the Canfields fell behind.
In early 2007, Washington Mutual started the foreclosure process. The couple asked the company to modify the loan instead, but it declined. The company said the Canfields credit was no longer good enough to qualify. It said they would have to repay $20,000 in overdue payments and penalty fees, or else face foreclosure.
The Canfields filed for bankruptcy instead, seeking a second chance.
"I guess I'm just stubborn," Kim said. "I want to keep my house."
Kim says she and her husband share responsibility for what happened. Lenders gave and the Canfields took. They accepted a larger loan than they could afford to repay. They didn't take the time to understand the terms. And they worked with companies that encouraged and allowed them to make bad decisions.
Under the proposed law, a judge could reduce the Canfield's mortgage debt to about $328,500, the estimated value of the home. The interest rate could drop as low as 5.6 percent, the current market rate. The couple's monthly mortgage payment might be reduced to about $1,900 a month, an affordable payment.
But any change will come too late for the Canfields. Earlier this month, a bankruptcy judge ruled that the lender can proceed with foreclosure unless the Canfields can make the full monthly payment, now about $3,200.
"It means that we'll lose the home," Kim said.
Consumer advocates say the benefit of changing the bankruptcy code is not just for the Canfields, but their neighbors. Foreclosures tend to destabilize communities and drive down property values.
"Even if you say there's an irresponsible borrower and an irresponsible lender, and a pox on both of you, it's protecting the third parties, and that's what's really important," said Adam Levitin, a law professor Georgetown University.
The mortgage industry cautions that protection would come at a high cost for those neighbors. The MBA has widely publicized an estimate that average interest rates would increase by 1.5 percentage points. Creighton, the chief lobbyist, said the number is a ballpark figure, but the group is certain rates would increase significantly.
Some academics say the estimate is baseless. Levitin said his research shows that interest rates might not increase at all. In a paper released earlier this month, he noted that mortgages on vacation homes - which can be reduced by bankruptcy courts - carry roughly the same interest rates as mortgages on primary residences, which can't be adjusted.
The paper also noted that the absolute ban on modifying primary home loans took effect in 1993. Before that time, courts in some parts of the country modified home loans, while courts in other areas did not. Levitin and a colleague found no pattern of higher rates in areas where courts modified loans.
"All the pricing data shows that the market doesn't care," Levitin said. "Allowing stripdowns would have little or no impact on interest rates."
The reason, Levitin said, is that any losses would be minor. A review of bankruptcy filings last year in Riverside County in California found lenders would lose about $40,000 on the average bankruptcy, less than they would lose if the same home went to foreclosure.
The proposed legislation also would tightly limit which homeowners can seek relief from a bankruptcy court - they must have a high-risk loan and demonstrate financial need.
Indeed, supporters say changing the law likely would reduce bankruptcy filings: There would be an initial rush of new filings, followed by a sharp drop. As the courts establish patterns, they say lenders and borrowers will have an incentive to reach an agreement on their own.
In other words, creating a parallel modification process could spur the industry's efforts to help borrowers.
"Right now it is not possible for most people who are in trouble with a subprime mortgage to get someone on the phone to talk to," said Elizabeth Warren, a law professor at Harvard University and a leading expert on consumer bankruptcy. "If the bankruptcy laws were changed and people can make a credible threat to go to bankruptcy and resolve it without the cooperation of the lender, then more lenders will come to the table."
Binyamin Appelbaum can be reached at firstname.lastname@example.org.